1. Field of the Invention
The present invention relates to a method for assessing a price for a commodity benchmark that minimizes volatility and non-normal swings in the benchmark price.
2. Description of the Background Art
Commodities, e.g., crude oil and agricultural products, are traded on a daily basis. The actual prices for which commodities are bought and sold have typically been extremely volatile, being affected by a variety of factors many of which are often difficult, if not impossible, to predict and beyond the control of traders. Because of this volatility, it is nearly impossible to predict what the market price for a specific commodity will be on some date in the future. In addition, because commodity trading is often conducted on very slim margins, an even slight miscalculation of a market price can spell financial disaster. Accordingly, most commodities are rarely traded on a fixed price basis. Most commodities are traded on what is known as a floating price basis. The price of a trade, or offer for trade, is not expressed in a fixed denomination, but is expressed as a benchmark, or baseline price, usually a market indicator or the spot price of a specified grade of the commodity, plus or minus a differential. That is, the price of a sale today of a commodity for delivery on a future date certain may be expressed as the benchmark price of the commodity that will be established on the date certain adjusted, up or down, by some agreed-upon differential.
Crude oil is one of the most heavily traded commodities. Oil prices are a result of thousands of transactions taking place around the world, at all levels of the distribution chain from crude oil producer to individual consumer. Oil markets are essentially a global auction—the highest bidder will win the supply. Like any auction, however, the bidder doesn't want to pay too much. Likewise, the seller does not want to sell too low.
There are several different types of transactions that are common in oil markets. Contract arrangements in the oil market in fact cover most of the oil that changes hands. Oil is also sold in “spot transactions,” that is cargo-by-cargo, transaction-by-transaction arrangements. A spot transaction is an agreement to buy or sell one cargo of oil under a price agreed-upon at the time of the arrangement. In addition, oil is traded in futures markets through exchanges, such as the New York Mercantile Exchange (NYMEX) and the International Petroleum Exchange (IPE). A futures contract is a promise to deliver a given quantity of a standardized commodity at a specified place, price, and time in the future. Futures markets are a mechanism designed to distribute risk among participants on different sides (such as buyers versus sellers) or with different expectations of the market, but not generally to supply physical volumes of oil. The exchange records the pairings of buyers and sellers, and reports the transaction prices. Various reporting services report the transactions with minimal lag. Both spot markets and futures markets provide critical price information for contract markets. Spot prices provide information about current supply and demand, rising when supply is low relative to demand and falling when supply is high relative to demand. Futures contracts provide information about market prices for future delivery.
As with many other commodities, forward contracts in crude oil traded on international markets is traded on the basis of floating prices: a base price plus or minus a differential. A common pricing term sets a base price of a spot price published by a particular source or publication. For crude oil sold into the United States Gulf Coast, for example, the base would commonly be the price of West Texas Intermediate (WIT) crude oil. Crude oil sold into much of Europe and across the Atlantic is often tied to the spot price for the North Sea's Brent Blend, and crude oil sold into Singapore or other South East Asian locations is often tied to Dubai crude. The Brent blend is technically a mix of crude from the Shell UK-operated Brent field and the British Petroleum-operated Ninian field. The blend is, however, commonly referred to simply as Brent. The differential is often tied to a quality difference in the actual blend being traded as compared to the benchmark blend. For example, a transaction involving Oseberg crude oil, another North Sea blend, may include a price expressed as follows:                900,000 bbl cargo of Oseberg loading July 31-1 August traded at Dated Brent plus 5 cts.        
In the above example a seller agreed to sell to the buyer 900,000 barrels of Oseberg blend to be delivered between July 31st and August 1st for a price of the Dated, or spot, Brent price that will be set on the date of delivery plus a five cents per barrel premium.
The price that will be set on, or around, the date of delivery will be an assessment of the benchmark price. An assessment is a determination of the repeatable, tradable price range for a commodity during the assessed period. The goal of an assessment is to focus in on typical transactable levels, typically by discarding unrepresentative market information (out-of-market bids, offers and transactions). The assessment process differs in this respect from indexation, which is an inclusive process, averaging all available market information. Assessments are typically published as a low-high range for each commodity instrument. Accordingly, the price ultimately paid for the cargo will depend on the spot price assessed on the date of delivery and the differential. Therefore, crude oil trader can maximize the price paid in a transaction by either maximizing the benchmark price or maximizing a premium (i.e., positive) differential (or minimizing a discount (i.e., negative) differential).
Floating pricing based on a specified benchmark price tied to a specified grade of the commodity provides an acceptable pricing scheme as long as the spot price of the benchmark grade is reflective of normal market conditions. If, on the other hand, the price of the benchmark grade becomes exceedingly, and unnaturally, volatile or if the benchmark price increases or decreases by large amounts due to non-normal market forces, the prices of all other grades of the commodity that are tied to the benchmark will exhibit similar aberrant tendencies. Such unnatural market forces may occur when there is a squeeze in the market, that is, when the supply of the benchmark grade is artificially restricted, thereby artificially driving up the benchmark price. Unnatural market forces can also occur if an atypically large volume of the benchmark grade is suddenly dumped onto the market, thereby artificially creating a glut of the benchmark grade and driving down the benchmark price.
A benchmark price becomes susceptible to such non-natural market conditions, and more particularly to market squeezes, when there are low volumes of the benchmark grade that are available for trading. When there are low volumes of the benchmark grade available, a relatively few market players can corner the market by buying up all available tradable supply of the benchmark grade and then restricting the supply to drive up the benchmark price. This is what has occurred in the crude oil markets tied to the Brent blend and the Dubai blend. Because the output productions of Brent and Dubai blends have declined in recent years, there are relatively few Brent or Dubai cargoes available for trade in any given month. For example, due to increasing problems caused by aging fields, production of Dubai in 2002 dropped down to close to 10 monthly cargoes of 500,000 barrels each from close to 30 cargoes a decade earlier. The number of cargoes of each blend has dropped so low that a single participant in the international crude oil market could easily buy all of the available cargoes of either blend to corner the entire market tied to that blend. With the benchmark grade squeezed, the benchmark price, or assessment, can increase dramatically along with all other crude oil grades whose price is tied to the benchmark.
There are a number of possible solutions to squeezes in a benchmark grade of a commodity.
An alternative grade could be selected. That is, the current benchmark grade could be replaced by a different grade for which there is sufficient available, transactable volume so that squeeze and other market aberrations associated with, or caused by, low volumes of the benchmark grade are avoided.
Replacing a benchmark grade can, however, be extremely disruptive to the market. Numerous transactions involving large sums of money would have already been concluded based on the old benchmark. Moreover, many of the transactions will not have been consummated until well into the future with an ultimate price that will be tied to the old benchmark. Furthermore, it is not uncommon for other tradable financial instruments having values tried to the benchmark (known as derivatives) to be developed over the course of time. Such derivatives, for which there is an active trading market, may cease to exit or would have to be converted over to the new benchmark grade if the old benchmark grade were replaced.
Another possible solution would be simply to ignore market squeezes when developing benchmark assessments. This solution may not be satisfactory if the squeeze is prevalent in the market thereby leaving few, if any, arms-length transactions for assessing the benchmark.
It has been known to average the price of two or more grades of a commodity. For example an average price of three North Sea crude oil blends: Brent, Ekofisk, and Forties is traded as a derivative known as the North Sea Basket. The North Sea Basket has not, however, been employed as a benchmark. Moreover, an average, since it will include all transactions involving the averaged grades of the commodity, will still reflect, albeit in a moderated manner, any aberrant, non-fundamental market behavior of any of the constituent grades of the average.
Therefore, there exists a need to devise a means by which leverage in benchmark commodity grades can be diluted and to reconnect the value of the benchmarks to normal market fundamentals.